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Alphabet Falls Short on Currency Headwinds, Ad Product Changes

Don't be fooled by the tech giant's headline numbers. This was another strong quarter from the parent company of Google.

Alphabet (NASDAQ:GOOG)(NASDAQ:GOOGL) released first-quarter 2019 results on Monday after the market closed, and the market obviously isn't pleased.

The parent company of Google was down 8.3% early Tuesday as of this writing after its top line technically fell short of Wall Street's expectations -- but that doesn't mean Alphabet is displeased with its results.

Let's dive in for a better idea of how Alphabet started the year and what investors should expect as we look ahead.

Image source: Alphabet/Google.

Alphabet's consolidated results (and that big antitrust fine)

Alphabet does not provide specific quarterly guidance, and we generally take Wall Street's demands with a grain of salt. But quarterly revenue grew 16.7% year over year to $36.339 billion, short of the roughly 19.9% growth most analysts were modeling.

That said, management pointed out during the subsequent conference call that revenue climbed 19% at constant currencies, contrasting the foreign-exchange tailwind Alphabet enjoyed in the fourth quarter of 2018. CFO Ruth Porat also noted that its slowing growth rate partly reflects a combination of a strong 2018 and "the timing of product changes in Ads" made in "the best interest of users and advertisers over the long term [that] we do not manage by quarter ..."

Meanwhile, GAAP operating income declined 15.5% to $6.608 billion, and net income fell 29.2% to $6.657 billion. A few items of note here: First, similar to what we saw in Alphabet's last quarterly update in February, GAAP net income included a roughly $1.5 billion benefit under the "other net income" line item of its income statement, driven by a combination of interest income and a $1.08 billion unrealized gain on Google's equity investments.

Just as Alphabet warned earlier this month, its earnings were also reduced by a $1.7 billion European Commission fine related to alleged antitrust offenses by Google's AdSense for Search business. Excluding the fine -- which Alphabet will almost certainly appeal, as it has with pastpenalties from the EU -- operating income would have increased 9.2% to $8.339 billion, and net income would have arrived at $11.90 per share, well above consensus estimates of $10.58.

Breaking down Google, Other Bets

Here's how Alphabet's two primary business segments -- Google and Other Bets -- fared over the past few months relative to the same year-ago period:

Metric

3 Months Ended March 31, 2019

3 Months Ended March 31, 2018

Year-Over-Year Growth

Google revenue

$36.169 billion

$30.996 billion

16.7%

Google operating income

$9.325 billion

$8.368 billion

11.4%

Other Bets revenue

$170 million

$150 million

13.3%

Other Bets operating income (loss)

($868 million)

($571 million)

N/A

Data source: Alphabet quarterly filing.

Advertising represented the vast majority of Google's revenue, as usual. Ad sales climbed 15.3% to $30.72 billion, including 16.7% growth from Google properties to $25.682 billion, and an 8.5% increase from network members' sites to $5.038 billion. Traffic acquisition costs (TAC) increased a modest 9.1% to $6.86 billion, trailing ad sales growth yet again and falling to 22% of Google's total ad revenue (down from 24% a year ago).

Paid clicks increased 39% year over year on Google properties, and cost-per-click (a metric showing how much Google makes per ad) declined 19%. Meanwhile, impressions on network members' sites increased 6%, and cost-per-impression on those sites rose 1%.

Google's other (nonadvertising) businesses continued to build their influence as well, with revenue climbing 25.1% year over year, to $5.449 billion, thanks to strong growth from Google Cloud and the Google Play store.

At the aptly named Other Bets segment, revenue growth was driven again by Fiber and Verily. But management noted Waymo recently announced a new production facility that will be the first dedicated to level-4 autonomous vehicles. The company's Loon business also recently received a new $125 million investment from Japan's SoftBank as part of a new long-term partnership to advance the spread of connectivity through the use of its high-altitude balloons. Alphabet's Wing drone-delivery company also became the first to receive air-carrier certification from the Federal Aviation Administration during the quarter -- something Porat described as "an important step toward beginning a commercial service delivering goods from local businesses to homes in the U.S."

Trending toward the bottom line, Other Bets narrowed its losses this quarter -- though we should avoid calling it a trend just yet. Management repeatedly reminds investors it's best to view this conglomeration of early-stage, high-potential companies through a longer-term lens.

Looking forward

Here again, Alphabet doesn't provide specific financial guidance. But Porat did caution that, assuming the U.S. dollar keeps strengthening against key foreign currencies, exchange rates will continue constraining growth in reported revenue and operating income in the second quarter. Porat also suggested that, due to a timing shift in planned expenses this year, sales and marketing costs at Google will pick up in Q2 relative to the first quarter.

Nonetheless, she concluded Alphabet is "confident about the opportunities ahead and we continue to invest thoughtfully for the long term."

Put simply, the primary factors behind Alphabet's revenue shortfall were foreign exchange and deliberate changes to its core advertising products made with the long term in mind. Furthermore, any perceived earnings weakness looking ahead is mostly a matter of Alphabet opting to extend its habit of reinvesting in the business for long-term growth. So while near-term traders focusing on the headline numbers may not be happy today, I'm not convinced Alphabet's share-price punishment fits the crime.

Author

As a technology and consumer goods specialist for the Fool, Steve looks for responsible businesses that positively shape our lives. Then he invests accordingly. Enjoy his work? Connect with him on Twitter & Facebook so you don't miss a thing.